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Now Europe Wants A Rate Hike, Too

November 07, 1999

News: Analysis & Commentary: The Economy

Now Europe Wants a Rate Hike, Too

If the U.S. economy were expanding at the same rate as Europe's--barely 2% this year--nobody would be expecting the Federal Reserve to hike rates. So why are European economists and investors bracing for an increase? On Nov. 4, the European Central Bank will meet, and betting is high that the 17-member governing council will hike its key refinancing rate, now just 2.5%, to as high as 3%.

The reason: a surprise 6.1% surge in European money supply in September from the year before. That spooked key ECB officials, including President Wim Duisenberg. Robin Marshall, director of European research at Chase Manhattan Bank in London, predicts "a preemptive interest-rate strike," if not on the 4th, then on the 18th.

Why risk a rate increase that could choke off an incipient comeback in key economies? After all, gross domestic product for the European Community is expected to expand by 2.1% this year and 2.8% next, healthy, but a far cry from the 4%-plus the U.S. has been sustaining of late. Economists are scaling back forecasts for Germany from 1.7% to 1.4%. Meanwhile, French consumer spending fell 2.6% in August and 1.8% in September, suggesting that French growth may be less robust than most economists thought.MONEY WORRIES. At the same time, there is scant inflation on the Continent--about 1.2% annually. And then there's the risk that a Euro hike will help convince the Federal Reserve to make a third quarter-point increase on Nov. 16 to shore up the dollar. Any slowdown in the U.S. would hurt European exports.

So why is the ECB so ready to pull the trigger? The most persuasive reason may be the rapid growth in money supply, which many on the governing council fear could create an asset price bubble similar to the one Alan Greenspan has cited as a danger signal in the U.S., despite a low inflation rate. In Europe, the bubble would most likely show up in property prices and not equity prices as it did in the U.S.

The ECB is also concerned with the rapid growth in some of its smallest and formerly poorest members, such as Ireland, Portugal, and Spain. In all three, growth has been far higher than in Germany, and prices have been rising more quickly. By moving to reflect their interests, the ECB could demonstrate that the days when European interest rates were set by the Bundesbank are truly over.

Some council members also want to take uncertainty out of the market. Duisenberg laid the groundwork for an increase on Oct. 26, when he told the European Parliament that a hike would not necessarily put a brake on the economy. Having flagged an increase, observers say, the ECB can ill afford not to follow up. Associates say Duisenberg has been working behind the scenes to put together a consensus in favor of a Nov. 4 hike.

Ironically, the Bundesbank, known for its inclination toward tight monetary policy, may be the most reluctant to go along with Duisenberg. First, the German Social Democratic-led government is about to present a budget to the upper house of Parliament for approval. More important, the Bundesbank fears stifling the German recovery.

Of course, the ECB could surprise everyone by waiting until Nov. 18 to make its move. But that seems unlikely. The Fed's Open Market Committee meets just two days before then. As one observer puts it: "The last thing the ECB wants to do at this stage in its development is to be seen to be following the Fed." Of course, nudging Europe into recession wouldn't look good either.By David Fairlamb in Frankfurt